In Russia, competitive pressures can raise the likelihood of innovation by 20%

33%

42%

47%

53%

30%

35%

40%

45%

50%

55%

No competitive pressure Low competitive pressure Moderate competitive pressure

Strong competitive pressure

Likelihood that a firm will introduce a new product

Source: BEEPS

What does the relationship between competition and innovation, which is by no means unique to this study, mean for policy? One implication is for industrial policy that has as its goal to facilitate the emergence of national champions. Actively targeting support to one firm in an industry, with the idea that it will attain the

critical size and degree of productivity necessary to be competitive globally, could weaken the entire industry’s incentives towards innovation. For the firm that is receiving public support, because to the extent that it can rely purely on domestic market power to generate profits, there is little reason to invest in costly innovation. Incentives to spend on R&D are blunted for its rivals as well (whether incumbent firms or potential entrants), because an uneven playing field means that any innovation will generate a return on a smaller customer base, since the domestic champion can use its larger capacity and excess profits as instruments to engage in aggressive pricing competition.

Now, the counterargument could be made that, if we believe that competition is an effective mechanism to promote innovation and thereby increase the competitiveness of the economy as a whole, then why does innovation policy not just rely on competition policy? The main reason is that market failures involving coordination of investments and information asymmetries for firms and for the markets from which they obtain essential inputs (among others, knowledge, human capital, finance) can weaken private incentives to innovate, as compared to the optimal levels from a social welfare perspective. Of course, one problem with this argument is that we have no good estimate of the optimal level of R&D/GDP at the micro- or macro-level. The EU goal of 3% is not anchored on an empirical analysis but is instead based on a comparison of present spending levels in the US, Japan, and other developed economies.

If we accept, for argument’s sake, that the 3% R&D/GDP target is the right one, there are still many options about the measures that should be put in place to reach this. Should the governments in CEE and Russia rush to imitate the success stories of other countries, such as the subsidies to venture funds that were used in Finland and Israel, the SBIR-administered grants to innovative firms in the US, etc.? Should the previous measures supporting the private sector be accompanied by actions and reforms in the public research, and what is the appropriate balance between the two? There are no correct answers to these questions, of course, because conditions in each country differ – in the dimensions measured by the KEI mentioned before, and there are many other relevant dimensions.

One crucial aspect is whether the government has the capacity to implement such policies, which will depend on balance on the strength of government vs. market failures. In post-transition economies, government intervention is liable to fail, or even cause harm, if the institutional framework is prone to problems such as capture by special interest groups and corruption. There are policies that are particularly at risk, such as those where a government agency is directly “picking winners,” as has occurred in industrial policy in the past.

Targeting policies, to favour a specific firm, product class, technology, or sector, has generally not proved helpful; although there are exceptions, since targeting is one way to induce more efficient coordination in the private sector, an important contemporary example being the selection of technological standards to ensure domestic and international interoperability.

The foregoing discussion raises the issue of policy design in the area of innovation, for which, as in other areas of government intervention, there are several principles that should be kept in mind. A recent World Bank study on public financial support for commercial innovation proposes two central principles. One is having policies that guarantee a neutral and transparent project selection. This can be achieved by having independent investment committees, incorporating international experts and civil society stakeholders in decisions-making, including technical assessments, and ensuring that proposals and decisions are open and transparent. The second is that risk-sharing should be instrumented, possibly through public-private partnerships. The key points here is to have PPPs that match the needs of public research organizations and firms, whilst preserving the incentives of each partner to invest resources and effort, and respond to market signals about the commercial perspectives of innovations.

To conclude, commercial innovation and the accompanying creation of scientific and technical knowledge drive microeconomic productivity and macroeconomic growth. Absorption is an important developmental activity that can precede but also accompany the efforts of industry to push established technical frontier.

Both activities are rife with market failures, some of which are inherent to the complex and uncertain nature of R&D-related outcomes, but others are a result of problems in markets for complementary resources, from the supply of skills and access (technical and managerial) to innovation finance (broadly thought to comprise early stage funding for high-tech firms and financing for research projects in larger companies).

Governments in ECA countries can help to resolve some of these problems, and thereby increase private incentives towards innovation, but in doing so special care needs to be taken about possible government

failures, particularly capture and corruption. Successful interventions implemented in other countries may have succeeded precisely because the institutional framework and economic constraints were different. One avenue to solve this is to carry out simultaneous reforms in education, ICT, or whatever the relevant bottleneck is. It is usually necessary to adopt the support measures as well, and in doing so it is useful to adhere to a few principles that have been shown to immunize public funding from common abuses and misuses. The most important are neutrality, transparency, and risk-sharing. Of course, like any other public investment decision, it is also crucial to carry out a cost-benefit analysis that takes into account the social gains (tangible and intangible alike).

Besides pointing to when and how the State can most effectively intervene in the national system of innovation, the results presented in this short paper have implications for activist technology and industrial policy. The two we highlighted have a common thread, which is that measures to foster improved productivity need to be aware of potentially perverse effects on private incentive structures. One example we discussed is that the impact of general purpose technologies like ICT requires investments and transformations to enable diffusion across sectors and firms, which may or may not be counted as innovations, but which can be much more important in terms of the benefits than the original innovations.

Supporting innovation but forgetting about the long diffusion process that follows can be a mistake. The other example is that undermining the domestic forces of competition in an effort to maintain national competitiveness can obstruct the enterprising spirit that is at the heart of commercial innovation.

References

Goldberg, Itzhak, Manuel Trajtenberg, Adam Jaffee, Julie Sunderland, Thomas Muller and Enrique Blanco Armas (2006), “Public Financial Support for Commercial Innovation: Europe and Central Asia Knowledge Economy Study Part I,” Chief Economist’s Regional Working Paper Series, Private and Financial Sector Development Department (ECSPF), Vol. 1, No. 1, World Bank January 2006.

http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/0,,contentMDK:2084990 1~pagePK:146736~piPK:146830~theSitePK:258599,00.html

Rodrik, Dani (2006), “Industrial Development: Stylized Facts and Policies,” forthcoming in UN-DESA, Industrial development for the 21st Century.

M. Piatkowski, B. Van Ark (2005) “ICT and Productivity Growth in Transition Economies: Two-Phase Convergence and Structural Reforms”-TIGER working Paper Series No. 72, Warsaw, January 2005.

Helpman, Elhanan and Trajtenberg, Manuel, "Diffusion of General Purpose Technologies" (September 1996).

NBER Working Paper No. W5773.

M M AR A RC C B B OG O GD DA AN NO OW WI I CZ C Z

: : T T HR H RE EE E F F RA R AM MI IN NG G C C ON O ND DI I TI T IO ON NS S FO F OR R

E E S S ER E RV VI IC CE ES S . . H H OW O W M MU UC CH H D DO O T TH HE EY Y AP A PP PL LY Y T TO O E E AS A ST TE ER RN N E E UR U RO OP P EA E AN N

M M EM E MB BE ER R S S TA T AT TE ES S ? ?

I

I wish to present in this short paper what I consider as three major framing conditions for a successful and useful deployment of public eServices in the Eastern European Member States (EEMS), in line with the leapfrogging ambitions that those countries legitimately ambition. Hence, I will not speak specifically of eGovernment, as the title of the panel might legitimately induce, but in a broader sense of eServices and the challenges to their emergence.

This aim will drive us to discuss successively - from the most to the much less obvious: from the still controversial assessment of the Information Society state-of-development in the EEMS, then to the conditions and mechanisms of innovation, and finally the prospects and nature of future ICT applications.

This paper has to be seen as rooted strongly in the general empirical and theoretical framework developed by Prof. Carlota Perez41. We are interpreting here reality, the observed facts, while considering that we might be assisting – at least in the so-called advanced economies – to the early years of the deployment phase of a new techno-economic paradigm where Information and Communication Technologies (ICT) play the central role of pervasive technology, a "constitutive technology" as expressed recently by the ISTAG42.

In the case of the EEMS, some caution will be taken and will be reflected in the paper, as precisely those countries might be among non-core economies, described by Professor Carlota Perez, that historically have a chance to join the core ones only if taking advantage of the changing production paradigm. This is when leapfrogging occurs.

Last but not least, the thoughts that I am sharing here owe a lot to a broad range of studies effectuated at, or commissioned by, the Institute for Prospective Technological Studies (IPTS) to which I also belong. In particular, I would like here to refer to the studies on the EEMS coordinated for IPTS by Professor Pal Gaspar, from the International Centre for Economic Growth of Budapest, the debates animated by IPTS in the Scientific Steering Committee for the IS take-up in EEMS as well as the in-house research line launched at IPTS on eRuptive trends.

The paper is organised around what we consider three framework conditions for the emergence of successful eServices:

1. The Information Society take-up in EEMS 2. The role of Innovation in the deployment phase

3. The prospective dilemma of AmI versus Web2.0 applications